An extremist, not a fanatic

October 31, 2010

Profits & top incomes

Profits are up, share prices are up. What do you think should happen to the wages of people hired to increase profits and share prices?

This raises the question: what is the link between top incomes and profits?My chart sheds light here. I‘m taking the share of the top 0.5% of incomes in total incomes from Emmanuel Saez‘s data, and profits from national accounts data. This shows that, over the long-run, there is a rough correlation: both shares have a U-shaped pattern, troughing in the mid-70s.However, since the late 80s, the correlation is less obvious. The share of profits in GDP was lower in 2005 (the latest year for Saez’s data) than in the late 80s. But the share of the top 0.5% in total incomes doubled during this time.In recent years, then, moves in aggregate profits cannot explain moves in top incomes. The power of capital to exploit labour hasn’t changed much, but the power of top earners to seize incomes has increased.I suspect there are two big reasons for this.One lies in efficiency wage theory. Top bosses and bankers must increasingly be bribed not to seize corporate assets for themselves - partly because these assets consist more of portable things like goodwill or financial products and less of hard physical capital. At the same time, the need to bribe ordinary workers to behave well has declined as IT allows more direct monitoring of them.Another lies in managerialist ideology. Firms believe that success requires them to hire super-talented managers, and so there’s a bidding war for talent.In large part, there’s a fallacy of composition here. In aggregate, profits depend upon macroeconomic and institutional factors, not the skill of managers in total. But what if there’s a germ (or more!) of truth in this ideology? Could it be that success for individual businesses today really does depend more upon the skill of managers and less upon corporate-specific assets, such as monopoly power or product quality? If this is the case, then the rise of top incomes is, in a sense, a symptom of the fragility of capitalism - because a firm that’s dependent upon the talent of individuals is one that is highly vulnerable to failure.

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"That’s what happened to Victorian Britain, he suggests, when it was surpassed by the United States and Germany. Britain had capable businessmen and good financial markets to support them. There’s no evidence that Victorian businessmen failed to invest wisely. The problem, argues Nye, is that they didn’t invest unwisely."

The top 0.5% is 150,000 taxpayers in the UK. There's a big chunk of all sorts of other people in that number: most professional sportsmen, most of the successful people in the entertainment industries, actual entrepreneurs not just execs and so on and so on.

I still maintain that a goodly chunk of top people's wages ( top meaning top 1%, 0.1%, to taste) is determined by this globalisation thing. The few people who are able to earn pennies from billions worldwide rather than pennies from millions domestically.

For those to people's wages do seem to have risen everywhere, whatever is happening to corporate profits etc etc.

Er, what, exactly, is the difference between being bribed not to seize corporate assets and, um, actually just seizing them?

Couldn't it well be asked whether senior corporate management - the supposed 'agents' - are actually now, in a de facto sense, the 'principals' as they have effective control of the distributions of the firm's assets?

I think it is misleading to look at boardroom 'salaries' as in any way akin to 'salaries' like for normal people, or to regard them as a business expense.

They are in fact a priority profit share. The 'business' makes profits after paying market salaries to actual working people, and then the profits are divvied up between the directors and the shareholders.

High footballer salaries aren't paid by 'the fans' either, they are paid more or less directly by very rich businessmen with massive egos who are prepared to bankrupt themselves by buying a football team.

And finally, high salaries for civil servants, solicitors (esp. 'human rights' lawyers), auditors etc aren't really salaries at all, they are more akin to rents - without the government there to invent all the stupid rules, we wouldn't need nearly as many of these people.

1. the earnings of the top 0.5% is highly volatile and subject to measurement errors. This is a property of estimation of high and low quantiles.

2. these earnings are not very meaningful. You are interested in managerial compensation, and are throwing in the picture a lot of earners who have nothing to do with it (well-paid professional, idiots like Beckham, etc.).

3. it's really hard to see any relationship that stands up to scrutiny. Try to plot the two series as paired observations, not as time series. Your "rough correlation" must be a new exciting sort of statistics. On my side of the world is called apophenia.

Two additional remarks:

1. the efficiency wage theory of management is appealing, but I wait to see better empirical evidence in its support. Actually, I am waiting to see better empirical evidence for anything that involves economy of information and principal-agent theory.

2. as for the fragility of capitalism because its dependency of managerial skills, it would be true in a world with one firm and one skilled but mortal manager. You are ignoring that the world has a large number of skills and a large number of skilled, mostly interchangeable agents. One expect that averaging will reduce fluctuations here. If Jobs eventually dies of pancreatic cancer, Jony Ive may do a better job.

Having said that, I am always and forever a big fan of your blog, and of "The End of Politics". I quote them incessantly. But the last few posts must have been written under the influence.

Profit share? They do better than that. When there's no money in a company, there are no dividends for shareholders. You won't see a high level exec letting a little thing like that that stand in the way of their pay.